MNI POLICY: BOC Secondary Debt Buys Curb Political Blowback

The Bank of Canada’s recent debate about sticking with its pandemic-era shift toward buying more government debt in secondary markets versus at auctions of new securities is likely aimed in part at blunting political criticism around financing deficits with the central bank's balance sheet.

Deputy Governor Toni Gravelle's March 21 speech discussed normalizing a balance sheet that swelled to CAD575 billion from CAD125 billion during the pandemic and the future use of primary or secondary debt markets both have “pros and cons” he said. Considerations include market functioning, managing the Bank’s financial risks and transparency, Gravelle said.

Bank deliberations may also involve the new "floor system" of implementing monetary policy and Gravelle's estimate that requires up to CAD60 billion of settlement balances to make it work after unwinding QE.

Conservative Party Leader Pierre Poilievre, leading in polls ahead of an election due by next year, pledges to fire Governor Tiff Macklem and recently said “the Bank of Canada will once again have a mandate to keep inflation low, rather than creating cash through scams like quantitative easing.” Macklem told MNI the Bank is reviewing pandemic stimulus but the overall interventions worked. (See: MNI: Transcript of Interview With BOC Governor Tiff Macklem)

FISCAL DOMINANCE

"I suspect fiscal dominance issues are the crux" of the issue, Randall Morck, a former BOC research fellow and a professor at the University of Alberta, told MNI. "Restricting BOC transactions to primary issues would let the government pick the maturities the BOC would be restricted to buying."

Morck also referenced political debate around “Modern Monetary Theory” where some people have argued officials can push the limits of big deficits. Some economists through the pandemic also warned of perceptions around “fiscal dominance” over monetary policy amid rising public debt. (See: MNI: Canadians Doubt BOC Wins Inflation Fight-Internal Polls)

The Bank reported unprecedented losses following QE as it turned to raising rates and those balances paid out more than the government bonds it purchased.

Jeremy Kronick of the C.D. Howe Institute and a former BOC researcher said primary market purchases can create the appearance of comingling monetary and fiscal policies.

"It looks like you are buying debt directly from the government to support their actions," he said. "The best way to do it is to continue the way it’s been done, use the primary market for responding to cash demand, and then use the secondary market as needed for stresses and for tweaks to the settlement balances."